What to Do With Your 401(k) When Changing Jobs

When changing jobs, managing a previous employer’s 401(k) retirement account requires careful thought. This account represents accumulated retirement savings, and deciding its fate has distinct implications for growth, accessibility, and taxation. This article clarifies the choices available to help individuals manage their retirement assets effectively.

Key Factors in Your Decision

Several factors influence the decision of what to do with a 401(k) when changing jobs. Evaluating these elements helps individuals align their choice with personal financial goals and risk tolerance.

Fees and expenses vary significantly across retirement accounts, including administrative, management, and investment fees. Higher fees can substantially reduce long-term returns.

Investment options differ between account types. Some 401(k) plans offer a limited selection of funds, while IRAs typically provide a much wider universe of choices, including individual stocks, bonds, and exchange-traded funds (ETFs). This offers greater control over your portfolio.

Rules for accessing funds before retirement, such as through loans or early withdrawals, vary by plan. Some 401(k) plans permit loans, but IRAs generally do not. Early withdrawals from either account before age 59½ typically incur a 10% penalty in addition to ordinary income taxes, though limited exceptions exist.

Federal law provides creditor protection for retirement accounts. Employer-sponsored 401(k) plans are generally protected under the Employee Retirement Income Security Act of 1974 (ERISA) from creditors, including in bankruptcy. IRAs also receive some federal protection in bankruptcy under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), but their protection outside of bankruptcy often depends on state laws.

Required Minimum Distributions (RMDs) generally begin at age 73. An exception allows individuals still working to delay RMDs from their current employer’s 401(k) plan until they retire, provided they are not a 5% owner of the business. This “still working” exception does not apply to IRAs or 401(k)s from previous employers.

Rolling Over to an Individual Retirement Account (IRA)

Rolling over an old 401(k) into an Individual Retirement Account (IRA) is a popular choice for individuals changing jobs. This process moves retirement funds from a former employer’s plan into an IRA, often providing greater control over investments and potentially more diverse options than a previous 401(k).

Direct Rollover

A direct rollover transfers funds from your old 401(k) administrator directly to your new IRA custodian, avoiding tax withholding and penalties. To initiate, gather your old 401(k) account number, plan contact information, and details about the types of assets held. From your new IRA custodian, obtain the account number and routing instructions. Many IRA custodians provide a “letter of acceptance” that the old 401(k) administrator may require. Submit the old 401(k) rollover request form with new IRA details. The old plan then processes the request, arranging for the funds to be transferred directly to the new IRA custodian. This transfer can occur via electronic wire or a check made payable directly to the new IRA custodian. You do not receive the funds, which helps ensure the tax-deferred status of the money is maintained. Confirm receipt with your new IRA custodian.

Indirect Rollover

An indirect rollover, also known as a 60-day rollover, involves the old 401(k) plan distributing funds directly to you. You then have 60 days to deposit the money into an eligible IRA. The administrator will withhold 20% of the distribution for federal income taxes, even if you intend to complete the rollover. This mandatory withholding means you will initially receive 80% of your account balance. You must deposit the full original amount, including the 20% that was withheld, into an IRA within 60 days. If the full amount is not redeposited, the portion not rolled over becomes a taxable distribution.

Tax Considerations for Rollovers

A direct rollover is a tax-free event, as the funds move directly between qualified retirement accounts without you taking possession. This avoids any immediate tax consequences or withholding.

Conversely, an indirect rollover involves mandatory 20% federal income tax withholding from the distributed amount. If you successfully roll over the full original distribution, including the withheld amount, within 60 days, the withheld amount is credited back when you file your tax return. Missing the 60-day deadline, or failing to redeposit the full amount, results in the unrolled portion being treated as a taxable distribution. This portion will be subject to ordinary income tax and, if you are under age 59½, an additional 10% early withdrawal penalty under Internal Revenue Code Section 72(t), unless an exception applies.

Rolling Over to a New Employer’s 401(k)

Transferring funds from an old 401(k) to a new employer’s 401(k) consolidates retirement assets, potentially simplifying financial management. This is suitable if the new employer’s plan offers competitive features, such as a strong employer match or favorable investment options. Confirm eligibility with the new plan administrator, as not all new 401(k) plans accept rollovers from previous plans.

Process and Tax Implications

To roll over, gather your old 401(k) account number and confirm the total eligible rollover amount. Your new employer’s 401(k) administrator will provide plan details, including contact information and routing instructions. Complete any required forms from the new plan. Submit these forms to your new employer’s administrator, who will then work with the old plan administrator to facilitate a direct transfer of funds. The funds are usually transferred electronically or via a check made payable directly to the new 401(k) plan. This direct rollover is generally a tax-free event, with no immediate income tax or withholding applied.

Other Options: Keeping or Cashing Out Your Old 401(k)

Besides rolling over, individuals have two additional options for managing their old 401(k) when changing jobs: keeping the funds in the former employer’s plan or cashing out the account. While keeping the account can be a viable choice under certain circumstances, cashing out typically carries severe financial penalties and is generally discouraged.

Keeping Your Old 401(k)

Leaving funds in a former employer’s 401(k) plan means the money remains invested and continues to grow on a tax-deferred basis. This option might be suitable if the old plan offers exceptionally low fees or unique investment options not available elsewhere. However, you lose the ability to make new contributions, and the former employer retains control over plan rules. You may also face higher fees for inactive participants and must proactively monitor the account, as you will no longer receive regular communications as an active employee.

Cashing Out Your Old 401(k)

Cashing out involves taking a direct distribution of the funds as cash, which is highly discouraged due to significant tax consequences. The entire distribution is typically considered ordinary income and is fully subject to federal and, if applicable, state income taxes. This can push an individual into a higher tax bracket, increasing their overall tax liability.

If you are under age 59½, an additional 10% early withdrawal penalty typically applies to the distributed amount, as detailed in the “Tax Considerations for Rollovers” section. Furthermore, a mandatory 20% federal income tax withholding is applied to the distribution, meaning you will receive only 80% of your account balance. For example, cashing out $10,000 from a 401(k) before age 59½ could result in $2,000 withheld for federal taxes, leaving $8,000. On top of this, you would owe ordinary income tax on the full $10,000 and an additional $1,000 (10% of $10,000) in early withdrawal penalties. This immediate loss of principal, combined with the forfeiture of future tax-deferred growth, makes cashing out a detrimental choice for long-term financial security.